The crisis in living standards & how to solve it

… the squeeze on living standards has tightened since the end of the recession.

This is an unusual state of affairs – as the Bank of England noted on Wednesday, real incomes in Q1 2013 were below their pre-recession peak whilst at a comparable point in the 1990s recovery they were up 12%.

The latest inflation and earnings data demonstrate the extent of the squeeze clearly:

The chart above though is subject to two important caveats. Firstly the most recent earnings data have been distorted by income shifting ahead of the 50p rate tax cut (as I’ve written about today on Left Foot Forward) and secondly because the data above deals with average rather than median earnings. The picture for median earnings is considerably worse.

But leaving aside these two caveats for the moment, the chart above also tells us something very important about what is causing our cost of living standards crisis. Contrary to popular believe, it is not primary down to inflation. Now of course inflation is having an impact (big rises in rail fares, food bills and energy prices are hitting people’s standard of living) but in reality the primary driver of the squeeze on real incomes has been weak wage growth.

The chart shows RPI inflation, average weekly earnings growth and real wages since March 2001. Whilst RPI got to elevated levels in 2003 and again from 2006 onwards, real wages continued to grow.

Over the period as a whole RPI averaged 3.0% – not very far from its current level. By contrast average weekly earnings growth averaged 3.2% – well below its current level (which is a reported 2.1% this month but stripping out distortions is almost certainly closer to 1.0%).

In other words the reason living standards are being squeezed is because of poor wage growth rather than high inflation.

So whilst there are no doubt important policy steps that could be taken to lower rail fares, cut energy bills or reduce other prices the best way to boost living standards would be to increase the pace of wage growth.

Going back to the above chart, the problem is that the blue line is too low rather than red line being too high.

It is unlikely that this can be achieved through traditional macroeconomic tools alone. A boost to demand would certainly help the labour market (and is no doubt required) but by itself it may not be enough. It is always worth remembering that stagnation of median real wages pre dates the crisis.

Looking at the US experience is instructive. Despite much better GDP performance than the UK since 2008, this has not helped boost real incomes as much as one would hope.

The picture in the US in terms of living standards is better than the UK but hardy ideal. Real incomes haven’t collapsed as they have in the UK, but nor have they grown strongly.

Policy needs to go beyond fiscal stimulus and look at wider issues about how wages are set in the UK. The TUC has recently published a pamphlet looking at this very topic. It identifies more than could be done with the minimum wage and the living wage and notes the crucial role of collective bargaining coverage in protecting living standards. But it also notes that in the medium term much of the work of increasing wages will require a rebalanced economy that creates more higher skilled, higher waged jobs in the first place. Achieving this means a modern industrial policy, corporate governance reform and changes to our banking system.

To solve the crisis in living standards policy makers have to realise that the crucial driver is not inflation but wages. Boosting wages is the only sustainable way to close the living standards gap.

Written by Duncan Weldon

Duncan Weldon was a Senior Policy Officer in the Economic and Social Affairs Department covering macroeconomics and regional policy. Before joining the TUC he had a fairly varied career taking in the Bank of England, fund management, the Labour Party…

[…] The crisis in living standards and how to solve it. Economist Duncan Weldon, the touchstone blog. As we are seeing the longest squeeze on living standards since the 1870′s, policy needs to focus upon wages, not on inflation. […]